Reading 66: Portfolio Concepts-LOS e 习题精选 capital, including, following, face, 2011

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Session 18: Portfolio Management: Capital Market Theory and the Portfolio Management Process
Reading 66: Portfolio Concepts

LOS e: Explain the capital asset pricing model (CAPM), including its underlying assumptions and the resulting conclusions.

 

 

Which of the following is NOT an assumption necessary to derive the capital asset pricing model (CAPM)?

A) Investors only need to know expected returns, variances, and covariances in order create optimal portfolios.

B) Investors are price takers whose buy and sell decisions don't affect asset prices.

C) Transactions costs are small for large investors.

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The derivation of the CAPM requires the assumption that transactions costs, and taxes are zero for all investors. Both remaining choices are necessary assumptions.

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Which of the following is NOT a prediction of the capital asset pricing model (CAPM)?

A) All investors identify the same risky tangency portfolio and combine it with the risk-free asset to create their own optimal portfolios.

B) All investors hold an equally weighted market portfolio of all assets.

C) The market price of risk is the slope of the capital market line.

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The CAPM predicts that all investors hold the market portfolio - a portfolio in which each asset is held in proportion to its market value. This portfolio is value-weighted, not equally weighted. The capital allocation line is then the capital market line (CML) and the market price of risk is the slope of the CML. The security market line (SML) describes the relationship between asset risk and expected return, where risk is measured by beta.

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According to the capital asset pricing model (CAPM), if the expected return on an asset is too high given its beta, investors will:

A) buy the stock until the price rises to the point where the expected return is again equal to that predicted by the security market line.

B) sell the stock until the price falls to the point where the expected return is again equal to that predicted by the security market line.

C) buy the stock until the price falls to the point where the expected return is again equal to that predicted by the security market line.

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The CAPM is an equilibrium model: its predictions result from market forces acting to return the market to equilibrium. If the expected return on an asset is temporarily too high given its beta according to the SML (which means the market price is too low), investors will buy the stock until the price rises to the point where the expected return is again equal to that predicted by the SML.

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An investor is considering an investment. After a great deal of careful research he determines that the forecasted return on the investment is 15% and estimates the beta to be 2.0. The risk-free rate of interest is 3%, and the return on the market is 13%. Should the project be undertaken?

A) No, the forecasted return is less than the expected return of 23%.

B) Yes, the forecasted return is less than the expected return of 18%.

C) Yes, the forecasted return is more than the expected return of 13%.

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Per the Capital Asset Pricing Model (CAPM), the expected rate of return = R_f + b[E(R_m) – R_f]> >= 3 + 2(13.0 ? 3.0) = 23%.> >

Since the forecated return of 15% is less than expected rate of return of 23%, the investment should not be undertaken.> >

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The market is expected to return 12% next year and the risk free rate is 6%. What is the expected rate of return on a stock with a beta of 0.9?

A) 11.4.

B) 13.0.

C) 10.8.

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ER_stock = R_f + ( ER_M ? R_f ) Beta_stock.

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Figment, Inc., stock has a beta of 1.0 and a forecast return of 14%. The expected return on the market portfolio is 14%, and the long-run inflationary expectation is 3%. Which of the following statements is most accurate? Figment, Inc.’s stock:

A) valuation relative to the market cannot be determined.

B) is properly valued.

C) is overvalued.

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Since Figment, Inc.’s, stock has a beta equal to 1.0, then the expected return of this stock is equal to the expected return on the market portfolio, which also has a beta of 1.0. Since Figment’s expected return is equal to its required return, the stock is properly valued.

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Callard Corp. stock has a beta of 1.5. If the current risk-free interest rate is 6%, and the expected return on the market is 14%, what is the expected rate of return for Callard Corp.’s stock?

A) 18%.

B) 20%.

C) 14%.

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ER_cc = 0.06 + 1.5(0.14 ? 0.06) = 18%

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According to the capital asset pricing model (CAPM), if the expected return on an asset is too low given its beta, investors will:

A) sell the stock until the price rises to the point where the expected return is again equal to that predicted by the security market line.

B) sell the stock until the price falls to the point where the expected return is again equal to that predicted by the security market line.

C) buy the stock until the price rises to the point where the expected return is again equal to that predicted by the security market line.

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The CAPM is an equilibrium model: its predictions result from market forces acting to return the market to equilibrium. If the expected return on an asset is temporarily too low given its beta according to the SML (which means the market price is too high), investors will sell the stock until the price falls to the point where the expected return is again equal to that predicted by the SML

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Leslie Vista has never been satisfied with the capital asset pricing model (CAPM) because of its restrictive assumptions. While the model seems to work fairly well in her own stock-valuation systems, she does not trust results that depend on assumptions that are unrealistic in the real world. Vista is a literal thinker and prefers tangible solutions. She does not hold with theory and rarely draws intuitive conclusions.

As an alternative to the CAPM, Vista decides to try out the arbitrage pricing model (APT). She likes the APT because it does not rely on the several assumptions that underlie the CAPM. Vista does some research comparing the CAPM to the APT and lists some of the assumptions of the CAPM:

• Markets are perfectly competitive.
• Investors use the Markowitz mean-variance framework.
• Represented by a multi-factor model.
• Unlimited risk-free lending and borrowing is permitted.

When Vista tells her boss, Mark Mazur, about her desire to use the APT, Mazur warns her of weaknesses in both models.  Mazur also explains that the company has established the capital asset pricing model as its in-house valuation method and advises that Vista familiarize herself with how to derive the capital market line (CML) and the security market line (SML).

After reviewing studies on the CAPM and the APT, Vista decides to develop her own microeconomic multifactor model. She establishes a proxy for the market portfolio, then considers the importance of various factors in determining stock returns. She decides to use the following factors in her model:

• Changes in payout ratios.
• Credit rating changes.
• Companies’ position in the business cycle.
• Management tenure and qualifications.

In order to derive the CML, Vista needs the:

A) expected market return, portfolio beta, and risk-free rate.

B) risk-free rate, market variance, portfolio variance, and expected market return.

C) market variance, portfolio beta, risk-free rate, and expected portfolio return.

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The CML is derived by using the risk-free rate, portfolio variance (standard deviation), market variance (standard deviation), and expected market return to calculate expected portfolio returns.

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Vista’s analysis of CAPM assumptions is flawed. Which of the following assumptions that Vista noted is not part of the CAPM?

A) Represented by a multi-factor model.

B) Investors use the Markowitz mean-variance framework.

C) Markets are perfectly competitive.

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The CAPM is represented by a single factor model with the factor being market risk. The APT is a multifactor model where several factors could be used to explain the model's returns.

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Which of the following factors is least appropriate for Vista’s factor model?

A) Companies’ position in the business cycle.

B) Management tenure and qualifications.

C) Changes in payout ratios.

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Microeconomic factors are factors measured by characteristics of the companies themselves, like price-to-earnings (P/E) ratios or growth rates. Macroeconomic factors are economic influences on security returns. A company’s position in the business cycle is dependent on the cycle itself, and cannot be accurately measured by looking at a company’s fundamentals. Payout ratios and management tenure are pieces of company-specific data suitable for use in a microeconomic factor model.

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After further research on valuation models, Vista is most likely to use:

A) the zero-beta CAPM because it does not require the assumption that investors can borrow at the risk-free rate.

B) APT because it allows the use of a variety of factors.

C) discounted cash flows, despite the need to estimate future cash flows and terminal values.

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APT, the zero-beta CAPM, and the security market line (part of the CAPM) are all theoretical models in that they require the use of assumptions that are impossible to justify rationally. Discounted cash flows (DCF) require some estimation, but the calculations are based on real, tangible data. In addition, DCF models are not difficult to test, and studies have shown that valuation strategies based on discounted cash flows can be successful at picking winning stocks. Since Vista is a literal thinker and prefers tangible solutions, she is most likely to use the discounted cash flow approach to valuation rather than a theoretical model.

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What is the beta of Franklin stock if the current risk-free rate is 6%, the expected risk premium on the market portfolio is 9%, and the expected rate of return on Franklin is 17.7%?

A) 2.5.

B) 3.9.

C) 1.3.

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Using the Capital Asset Pricing Model:

6% + beta (9%) = 17.7%

beta = 1.3